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HMRC as a preferential creditor in insolvency: what are the implications?

In the last budget, UK Chancellor Philip Hammond delivered a tax-focusedbudget announcing plans to make HMRC a preferential creditor in insolvency. It’s a move that comes with serious implications for UK business, most notably in reducing the chances of unsecured creditors being paid from insolvency.Once a company is ‘Wound up’ all creditors are informed and an insolvency practitioner goes into the business to assesses whether there are any assets available for liquidation. But before creditors can be paid, it’s important to know that there is a strict payment priority protocol in place. Not all creditors are created equal at least in the eyes of the law and, since there is almost never enough money to go around, the process must start somewhere.

The liquidation priority process works as follows:

First in line for the payment is the Liquidator and the costs of their services.

Then there are the creditors who had been granted security - like banks, lenders and finance providers. These are called the Secured Creditors.

After, and only after, the secured creditors have been paid, preferential creditors such as the company employees can get in line for their payout (and those claims are still subject to certain limits that the government has set in place).

After the company employees have been paid, unsecured creditors like suppliers, landlords, contractors and customers can be paid, and crucially for the purposes of this change, the taxman.

Exactly where the moral high ground sits on this decision is open for debate. On the one hand, companies collect tax on behalf of the government as soon as they begin to accrue revenues. So Her Majesty’s percentage is, in theory at least, only ever resting in company accounts. Conversely, if the government is seeking to reignite economic growth by way of business breaks then you could argue that leaving itself further down the payment pecking order would be a strong, low risk way to help out creditors and facilitate UK business cash flow.

Either way, the newly announced legislation comes into play in 2020, and it’s important that businesses are aware of the full implications of these changes and prepare themselves accordingly.

“Usually in the case of an insolvency payout there is just enough money for the secured creditors,” says Michael Higgins, Managing Director for Lovetts Solicitors. “More often than not the rest don’t get paid and if there is any money left for the unsecured creditors, it’s all placed into a creditors’ pot to be shared out equally. For example, each creditor might receive 10 pence for every £1 of debt.”

“For UK businesses, now is the time to get up-to-speed on your options and make sure you are as buttoned up as possible. For instance, when giving credit to a company consider whether you obtain a Personal Guarantee from a director. This way if a company does become insolvent you can have another chance of getting paid in full, this time from the director personally.”

For the Chancellor, bumping HMRC up to preferential creditor status may prove to be a good way to ingratiate the government with to the wider electorate, at a time when largescale corporate tax evasion is never far from the headlines. However in practice, we need to remember that such legislative changes always carry significant economic implications for businesses on the ground, and it is important to stay on top of these updates.